Price Elasticity Of Demand

Price Elasticity of Demand

T's Jean Shop sells designer jeans. The latest trend setter has been Capri cuffed blue jeans. The demand for the Capri jeans has been very high with teenagers and young women. The business has increased its supply of Capri jeans due to the high demand. The owner, Terri Johnson, contemplates increasing the price from $9.00 to $10.00. Ms. Johnson needs to know the response of the consumers to the increased price. According to McConnell and Brue (2004), the Price Elasticity of Demand measures the rate of response of quantity demanded due to a price change (p. 1).

Using Price Elasticity of Demand

In calculating the Price Elasticity of Demand, we use the formula:

percentage change in quantity

demanded of product X

Ed = percentage change in price

of product X

The percentage change in quantity demanded is divided by the percentage change in price.

change in quantity demanded of X

Ed = original quantity demanded of X

change in price of X

original price of X

According to Economics.about.com, there is another way to view this equation (www.economics.about.com). The equation is:

The percentage of change in quantity demanded is:

[QDemand(NEW) - QDemand(OLD)] / QDemand(OLD)

The percentage of change in price is:

[Price(NEW) - Price(OLD)] / Price(OLD)

T's Jean Shop original price for the Capri jeans was $9.00 and the new price is $10.00. So we have the Price (OLD) = $9.00 and Price (NEW) = $10.00. The quantity that has been demanded for the $9.00 is 150 and the increased price of $10.00 is 110. When you go from $9.00 to $10.00 you have QDemand(OLD)= 150 and QDemand (NEW) = 110, where QDemand is short for Quantify Demanded. So now the equation is

Price(OLD) = 9

PRICE(NEW) = 10

QDemand(OLD) = 150

QDemand(NEW) = 110

The percentage change in quantity demand and percentage change in price percentage is needed to calculate the price elasticity. The formula used to calculate the percentage change in quantity demanded is[QDemand(NEW) - QDemand(OLD)] / QDemand(OLD), which will give you values of [110 - 150] / 150 = (-40/150) = -0.2667. Now the percentage change in price needs to be calculated. The formula to use is {(Price(NEW) - Price(OLD)] / Price(OLD), which will give you values of [10 - 9] / 9 = (1/9) = 0.111.

The last step of the formula is the PEoD or Price Elasticity of Demand calculating the two percentages in this equation using the earlier calculated figures which are PEoD = (0.2667)/(0.1111) = 2.4005.When we analyze price elasticity, the concern is for their absolute value. The negative value (minus sign) is ignored. The equation has concluded that the price elasticity of demand for the price increases from $9.00 to $10.00 is 2.4005.

The Interpretation of Ed reveals that it is not the numbers economists are interested in, but how the Price Elasticity of Demand shows consumer sensitivity. In T's Jean Shop, it is the customer's sensitivity to the increased price of the Capri jeans. The higher the price elasticity, the more sensitive consumers are to price changes.

High price elasticity suggests that when the price of good goes up, consumers will buy a great deal less of it and when the price of that good goes down, consumers will buy a great deal more. Low price elasticity implies just the opposite, that changes in price have little influence in demand. To figure out if the Capri jeans price increase is elastic or inelastic.

According to McConnell and Brue (2004), "The coefficient of price elasticity of demand interpretation of price elasticity of demand is if the equation is above 1, then the demand is price elastic, which is a specific percentage change in price results in a larger percentage change in quantity demand" (p. 2). If the percentage change in price and the resulting percentage change in quantity demanded are the same it will each 1 and the demand is called unit elastic.

Inelastic demand is a specific percentage change in price producing a smaller percentage change in quantity demanded